Will the RBI move to protect customers?

There has been a sharp rise in gold loans in recent years. But there is a seedier side to this, as is evident from the red flag the RBI raised recently. Will the regulator’s move protect customers?


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On a sunny day in March, Nirmal Jain, MD of financial services company IIFL Finance, got a notice from the regulator, the Reserve Bank of India (RBI).

The RBI asked the company to immediately stop its gold loan operations, which accounts for a third of its business. The reason: the regulator found some major lapses in how the company handled the loans.

When the regulator looked into the company’s finances as on March 31, 2023, it found several lapses, like how the company checked the purity and weight of gold when giving out loans and during auctions after borrowers defaulted. It also found that IIFL Finance had given out and collected cash loans way above the statutory limit. It had not adhered to the standard auction process, and there was a lack of transparency in the charges being levied on customer accounts. 


” Our commitment to compliance is unwavering, and we are optimistic that the upcoming special audit by the RBI will validate our adherence to these standards “

NIRMAL JAIN
MD
IIFL Finance

 

And IIFL Finance isn’t the only one under the scanner for concerns related to the gold loan book. Bank of Baroda’s internal audit found that many gold loan accounts were closed within one to three days, 238 were closed on the same day they were given, and 2,512 were opened and closed during a gold loan drive. When contacted, the bank said it had done a thorough check and found no discrepancy in the vast majority of cases. In fact, some of the bank’s branches reportedly disbursed gold loans without the collateral of gold as they scrambled to meet tough targets. A spokesperson for Bank of Baroda (BoB) said, “We would like to clarify that the bank has conducted an audit of its gold loan portfolio. We have found that all gold loans are adequately secured by gold jewellery as security.”

The restrictions on IIFL will remain till the RBI conducts a special audit. “In response to the RBI’s directive, we’ve thoroughly revised our policies, systems, and processes to align with the RBI’s guidelines. Our commitment to compliance is unwavering, and we are optimistic that the special audit by the RBI will validate our adherence to these standards,” Jain tells Business Today.


But this isn’t a problem restricted to gold loans. There has been visible exuberance in the personal loan space, including gold loans, since the Covid-19 outbreak, and some financial institutions appear to have resorted to questionable practices when the going was good. To get a sense of scale, one need only look at the RBI’s actions in the past six months. First, it pricked the bubble by increasing risk weights on unsecured personal loans, which meant banks and non-banking financial companies (NBFCs) had to reserve more capital against such loans. Then it came down hard against Paytm Payments Bank for persistent compliance issues. That was followed by the actions in the gold loans segment.

It’s evident that the RBI, stung by a series of NBFC failures before the pandemic that threatened the stability of India’s financial system, will move fast at the first sight of froth.

RBI Governor Shaktikanta Das called these instances outlier cases and played down concerns of a system-wide problem in his address to the media after the bi-monthly monetary policy meeting at the beginning of April. But players in the sector seem to have heard the message loud and clear: It’s time to get the books in order.


” Banks prefer external valuers [for gold] as they are certified… and have experience in evaluating gold ornaments. Therefore, making use of the professional services of valuers is a better option “

SHRIPAD JADHAV
President–Retail
Agri & Gold Loans
Kotak Mahindra Bank

 

DEEP ROT

The problem with gold loans goes quite deep. In February, the Association of Gold Loan Companies asked the RBI to investigate certain bank branches for breaking the rules governing how much money can be given against gold ornaments.

In August 2020, the central bank allowed banks to give out more money against gold ornaments to help people facing financial difficulties tide over the immediate Covid-19 crisis. It raised the maximum loan-to-value (LTV) ratio—or the proportion of gold value that can be raised as a loan—from 75% of the value of the gold ornament to 90%, but only until March 31, 2021. But entities were found to have lent at the higher LTV even after that period. 

With growing concerns about the handling of gold loans, even the finance ministry has had to step in. It recently told public sector banks to check their gold loan records and follow the rules set by regulators. “We’ve asked banks to conduct a comprehensive review of their gold loan operations,” Vivek Joshi, Secretary of the Department of Financial Services, said recently. 


“Gold lending is more of an on-the-ground business where one of the key underwriting measures is testing purity and then arriving at the value of the gold. Practices around the quality of testing and, hence, the corresponding level of aggressive underwriting, given the competition in the market, are a key industry concern,” explains Sanjay Doshi, Advisory Head for Financial Services at consulting firm KPMG in India. “This is crucial as there could be overleveraging if the LTV ratio becomes high.”

Another issue that has cropped up in the segment concerns the amount of cash that can be given out against the gold loan. BT came across many cases where gold loans were offered in cash above the limit of Rs 20,000 set by the RBI. It appears that some firms made use of a regulatory arbitrage between the rules of the RBI and the income tax department.



Sumit Sharma 
Founder
Radian Finserv

 

“There is confusion between the Rs 2 lakh limit allowed by the income tax department and the Rs 20,000 limit imposed by the RBI when it comes to the cash limit on gold loans,” an industry player tells BT, on the condition of anonymity. But the RBI, which is the regulator of the financial sector, has made its stance clear in the IIFL case, asking the NBFC to cap its cash disbursements to Rs 20,000 and stop the practice of disbursing up to Rs 2 lakh.

“For gold loans, as a policy, we do not disburse cash. We disburse all our loans to bank accounts only, which can be a Kotak account or any other bank. This ensures traceability of the borrower. It is important for the bank to know the recipient and the purpose of the disbursed funds,” explains Shripad Jadhav, President–Retail Agriculture and Gold Loans at Kotak Mahindra Bank.

On the issue of “significant disbursal and collection of loan amount in cash far in excess of the statutory limit,” in an analyst call, Jain admitted that IIFL Finance had been disbursing and collecting gold loans in cash up to Rs 2 lakh.


What’s It Worth?

One clear violation that the RBI has highlighted is the process of assessing the worth of gold. In an ideal situation, the gold is assessed for weight and purity, and the loan is advanced based on such an assessment. 

But what if a 20-carat gold ornament pledged is assayed at 22 carats? Then the amount of money that can be loaned out increases because of the higher valuation of the gold. 

For instance, IIFL Finance offered loans against gold to over 1.9 million customers, out of which 82,000 loans went for auction. In these, the RBI identified discrepancies between the value of the gold and the loan amount offered to customers in 55,000, or a whopping 67%, of the cases.

Of course, this arrangement is beneficial for both the borrower and the lender because the borrower gets access to a higher quantum of money than they are entitled to, and the lender retains a customer in the face of intense competition. 

But what happens if a borrower defaults in this case? Now, the only way to recover the loaned amount is to auction the gold pledged. But then the buyer at the auction will only buy the gold at the prevalent price of 20 carats, leaving the lender to foot the difference. 

There could be instances where after the auction the surplus money is adjusted to meet the shortfall. Remember that the lender can only advance a loan worth 75% of the gold ornament’s value, so after the auction, the lender is bound to return the remaining 25% of the item’s value to the borrower, minus charges.

“Auction should be done in a way that the buyer does not suffer and the lender also recovers money. So, at the time of the auction, one needs to look at what is sold and at what value. Is it fair? What charges are being levied? Whatever surplus money was left, is it returned to the borrower?” says KPMG’s Doshi.


The Gold Loan Boom

What next for the segment? Without a doubt, there has been a boom in the gold loans market in recent years. Right now, the gold loan market is sitting pretty at over Rs 6 lakh crore (including agricultural gold loans), compared to just Rs 2 lakh crore in FY13. That’s a CAGR of 11.8% over the last decade. Impressive as that is, growth has been even better since the outbreak of Covid-19, with a CAGR of 22.7% in the three years to FY23.

And, the potential seems endless in this segment if you consider the fact that almost every Indian household has some gold lying around. So much so that India’s gold holdings total a mind-boggling 27,000 tonnes, valued at $1.5-2 trillion. Only 7% of that has been pledged as collateral for loans. “People tend to think of gold as a family heirloom, but it can do so much more. Whether it’s an emergency or a dream you’re chasing, gold can be your secret weapon,” says Jadhav. 

According to a report by brokerage firm Nirmal Bang, at the average market price of Rs 62,219 per 10 gm of gold in December 2023, monetising even 20% of the gold stock in the form of a loan at a 70% LTV ratio is expected to lead to a Rs 24 lakh crore market opportunity for financiers. 


Add to that the fact that gold has been on a roll in 2024, touching an all-time high of more than Rs 73,000 per 10 gm—an increase of nearly 21.1% in just one year between April 18, 2023, and April 18, 2024—and you suddenly realise that the gold you hold can fetch that much more if pledged.

That’s why the gold loans business moves in tandem with the price of the yellow metal. People realise that their gold is worth more as collateral, allowing them to get bigger loans for the same quantity of gold. That’s true even for those who have already pledged gold and availed of a loan. When gold prices go up, the LTV ratio goes down, meaning borrowers can get more credit for the same amount of gold. But if gold prices fall, the reverse is true, borrowers might have to pay back their loans sooner or put up more collateral to keep the LTV below the 75% limit.

“Except for the period FY13-17 (when RBI introduced restrictions on gold lending and gold prices were in decline), the 15-year correlation of Muthoot Finance and Manappuram Finance AUM with gold prices has been 99% and 96%, respectively,” says the Nirmal Bang report.



Rajesh Shet
Chief Executive Officer
SahiBandhu

 

The second reason for the surge in gold loans is that the stigma around pawning gold seems to be fading. Gold loans aren’t just for emergencies anymore. They’re becoming a trendy way for urban youth to fund their dreams. 

Rajesh Shet, Co-founder and CEO of gold loans platform SahiBandhu, says, “Taking out a gold loan has traditionally been seen as a last resort for financial emergencies. However, in recent years, borrowing against gold has become increasingly popular, especially among milennials. Many young people are now willing to utilise the gold stored in their lockers to address various financial needs.”

George Jacob Muthoot, Chairman and Whole-time Director of Muthoot Finance, too, highlighted this trend in his firm’s annual report for FY23. “We’ve seen a 50% jump in demand from the young… These kids are all about experiences over possessions. And that’s great news for us because it shows that the demand for gold loans isn’t going anywhere.”

Of course, it helps that gold loans are cheaper than personal loans. Gold loans are typically offered at 8-30% interest rate, compared with 12-48% for other personal loans. In the case of gold loans, even processing fees and foreclosure charges are much lower than with the other loans.

“Gold loans are quick, convenient, and involve minimal paperwork. Plus, you can even get doorstep service. Unlike other loans that require credit checks and income verification, gold loans are hassle-free. It’s all about unlocking the value of idle assets and giving the economy a boost,” says Sumit Sharma, Founder and CEO of gold loan dispenser Radian Finserv. 


The Road Ahead

But this period has also seen intensification of competition in the gold loans market, which for the longest time was dominated by NBFCs like Muthoot Finance. Muthoot still commands the highest market share at 44% in the NBFC space and has 6,169 branches and an AUM of Rs 79,500 crore in H1FY24. Muthoot, along with rivals like IIFL Finance, Manappuram Finance, and Muthoot Fincorp, accounted for 86% of the NBFC gold loan pie in FY23. 

These players now have to compete against big banks that have become more aggressive in recent years and have started grabbing a bigger slice of the pie since 2021. Part of the reason for this is the RBI’s decision to increase the LTV cap to 90% for retail gold loans mentioned earlier. 

Another reason is the increase in agricultural gold loans. Banks are more active in agricultural sector lending, which is classified as priority sector lending. As a result, a significant portion of the gold loans portfolio of many banks, like State Bank of India and BoB, consists of agriculture gold loans, when farmers pledge gold for a loan. This is why, when we consider agriculture loans, banks hold 77% of the gold loans market share, but when we exclude them, banks’ share drops to 39%, per a Nirmal Bang report. In the case of agri gold loans, there is no cap on LTV, and they can go up to 85-90%. 


And banks enjoy an advantage in this space, because their interest rates are lower. “Gold loans are typically offered at a differential of 8-10% where banks offer it at around 9-17% and NBFC at 20- 26%,” says Shet. NBFCs usually have higher interest rate because of the higher cost of funds, since they finance their operations through bank loans and market borrowings. 

NBFCs, meanwhile, are more agile than banks and their turnaround time is very short. The reason is that they have internal assessors to ascertain the value of gold, while banks usually depend on external entities for valuation. 

“Banks generally prefer external valuers as they are certified by the government and have experience in evaluating various gold ornaments. Therefore, when it comes to valuation, making use of the professional services of valuers is a better option,” says Jadhav.

Considering the soundness of this logic, the RBI has been asking NBFCs to opt for external valuers, says an industry expert on the condition of anonymity. 

In light of the increase in bad loans in this space, it’s no wonder that the regulator has acted when it has. The average gross non-performing assets (NPAs) of gold loan for top four NBFCs rose from 1.8% in FY21 to 2.9% in FY22, before moderating slightly to 2.15% in FY23. Consider this: Muthoot Finance’s gross NPA was 0.9% in FY21 but increased to 3% in FY22 and further to 3.8% in FY23. Figures for FY24 are not available yet. 


As gold prices head towards newer highs, with the expected increase in demand for gold loans, it is time to tighten rules surrounding such loans to safeguard small, underprivileged borrowers, and the financial system. Another potential area of concern is the end-use of the loan, which is difficult to trace, unlike in a home loan where the money is directly transferred to the builder or seller. “If a loan is used for purposes other than stated, like investing in capital markets, it can be a concern, as money goes into high-risk activities, resulting in a higher risk of default,” says Doshi of KPMG. 

Clearly, it’s been a wild ride these past few years, and it’s not likely to slow down anytime soon, considering the appetite for quick money. That means the regulator will have to stay alert to step in at the first sign of any wrongdoing.

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UI Developer: Pankaj Negi
Creative Producer: Raj Verma
Videos: Mohsin Shaikh
Photos & Illustration: Nilanjan Das

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